Educational Articles

What is a Convertible Preferred Stock?

In most cases, convertible preferred stocks are similar to convertible bonds and respond accordingly in the market place. However, there are some differences between the two.

In most instances, a preferred stock is a perpetual instrument and, as such, does not mature. Its liquidation value—the stated value of the preferred stock at redemption—is an option of the issuing company. Preferred stocks rank ahead of common stocks, but below more senior obligations of the company, that is debt obligations. Therefore, holders of preferred shares will be paid before common shareholders. Dividends on preferred stocks are usually paid in quarterly amounts. However, dividends on preferred stocks are not secured and may be omitted. While corporations are required to pay interest on convertible bonds, they are not required to pay preferred dividends. Dividend payments are voted at the convenience of the company. But many preferred issues provide provisions for cumulative payments. That is, the corporation is obliged to make up omitted payments before it may distribute dividends to common stock holders. Furthermore, missed dividend payments give preferred shareholders the right to elect directors to the company’s Board of Directors. In general, preferred dividends are paid regularly.

If a convertible preferred stock trades on an exchange, its notation will be similar to a common stock. Convertibility is not generally indicated. However, prices shown are actual prices at which the preferred has traded, and not a percentage of par. Also, dividends shown are actual dollar amounts and not a percentage of par. For example, the Newell Financial $2.625 preferred pays an annually dividend of $2.625.

Whereas convertible bonds are debt instruments for a corporation, preferreds are considered equity. Convertible preferreds are generally protected against dilution. In addition, some preferreds may enjoy several added features. For example, the dividend on the common is increased above a certain level, if the preferred dividend would also be increased.